Farnoosh’s Mail Bag: How to Invest?
Your recent questions indicate some of you are focused on investing and retirement savings. That’s excellent! I love that my readers are so interested in securing their futures and building wealth.
Well, I’ve got some advice…
Hooman asks: “The stock market…is very confusing for me. What do you recommend to someone trying to build up his future. I am not sure what investment path to choose.”
Hooman, you’re not alone. The stock market is hardly an easy or predictable thing. Figuring out which direction stocks will move is anyone’s guess! The best way to invest and take advantage of the stock market – without the hassle of trying to understand its every move – is to participate in a tax-friendly retirement fund like your employer’s sponsored retirement fund (e.g. a 401(k)) and/or an individual retirement account (IRA). I’ve got more details on these investments here.
Neville asks: “I’ve been slowly getting my finances in order and I finally am in control (lots of debt and spending in my 20’s). I have a stable job, but feel behind in savings. How much should someone have by their mid 30s in retirement? If I have 10% of salary going to retirement should I increase to make up for my 20’s? Also, what is the average debt for people in my age range (with no mortgage).
Hooman, congratulations for getting your financial ducks in a row! We all make mistakes and run into a little (or a lot of) debt in our 20’s (myself, included). First things first (before beefing up retirement), I’d recommend you shore up at least 6 months of emergency savings. Calculate all of your fixed expenses for one month: housing, gas, food, utilities, insurance, etc. and multiply by 6. Try to sock away at least that much in a liquid account first. This will ensure that if you lose your job or run into a financial bind, you don’t have to resort to credit cards again to make ends meet.
Now, as for retirement, since you didn’t invest much – or at all – in your retirement account in your 20’s, I’d say try to invest a little bit more than 10% for now. You have some important catching up to do, I won’t lie. It’s hard to say how much you *should* have saved by your mid 30s. But I can tell you that when I started to save for retirement in my early 20’s, I put aside 10% every year. By the time I hit 30, I had a little over $60,000 saved. I actually just read a recent article on Slate.com that estimated how much we should have saved by a certain age, depending on our current average incomes. For example, a 40 year-old earning $100,000 should have roughly $200,000 in retirement savings. I don’t entirely agree with this chart (I think it’s a bit too aggressive). It’s an interesting assumption, but overall, I think there’s no way to calculate an exact answer for everyone.
Here’s some of my general advice on how to invest when it comes to saving in a retirement account:
Run the Numbers
How much you need to save depends on when you’d like to retire, in addition to what kind of lifestyle you envision having during retirement. Plan to live on the beach? Plan to work in retirement? You can crunch some of these numbers with help from your company’s 401(k) provider or, you can use free online retirement calculators at ChooseToSave.org and AARP.org.
Commit to 10%
If you have no clue when you plan to retire or what your expense will look like, a good rule of thumb is to invest at least 10% of your annual income into a retirement account, such as a 401(k) or IRA. The maximum contribution this year to a 401(k) is $17,500. For IRAs, it’s $5,500.
Diversification is a tried and true strategy to sound long-term investing. Aim for a mix of stocks, bonds and cash-like investments in your retirement portfolio. How to diversify, exactly? That depends largely on your age and risk tolerance. If you’re young and able to afford more risk, investing in 85% stocks, 10% bonds and 5% money market funds, may be one way to go.
Over time, it’s likely that your portfolio’s allocation will shift with movements in the stock market. For example, after a difficult year in the market, you may end up with too much weight in bonds and not enough in stocks. It’s important to rebalance your portfolio at least once a year to get it back to its original composition. Or, better yet – if your company offers it, opt for “automatic rebalancing,” which lets your plan manager rejig your investments automatically.
Avoid Knee-Jerk Reactions
As we learned in the previous recession, emotion-driven, knee-jerk reactions tend to be irrational, so avoid making any impulsive moves with your money when you watch stocks drop. You don’t want to pull out now, only to miss out on the rebound. Keep in mind: Many 401(k) investors who stayed the course managed to recoup their losses. In fact, according to Fidelity Investments, those who invested in target-date funds (aka age-based funds) and stayed the course during the 2008-2009 financial crisis, finished with the highest account balances by the summer of 2011, versus those who reduced or stopped contributing.